Question

Merrimac Manufacturing Company has always purchased a certain component part from a supplier on the East Coast for $50 per part. The supplier is reliable and has maintained the same price structure for years. Recently, improvements in operations and reduced product demand have cleared up some capacity in Merrimac’s own plant for producing component parts. The particular part in question could be produced at $40 per part, with an annual fixed investment of $25,000. Currently, Merrimac needs 300 of these parts per year.A) Should Merrimac make or buy the component part?B) As another alternative, a new supplier located nearby is offering volume discounts for new customers of $50 per part for the first 100 parts ordered and $45 per part for each additional unit ordered. Should Merrimac make the component in-house, buy it from the new supplier, or stick with the old supplier?C) Would your decision change if Merrimac’s annual demand increased to 2000 parts? increased to 5000 parts?D) Develop a set of rules that Merrimac can use to decide when to make this component, when to buy it from the old supplier, and when to buy it from the new supplier.

Answer 1

Answer:

See the explanation for the answers

Explanation:

A.

Cost of buying = annual requirement*price of the supplier

                             = 300*50

                             = $15,000

Cost of making = fixed investment+(annual requirement*cost of production per unit)

                         = 25,000+(300*40)

                          = 37,000

As the cost of buying is less than cost of making, Merrimac should buy.

B.

Total cost of buying from new supplier = $50*100 parts+$45*(300-100) parts

                                                                  = 5000+9000

                                                                  = $14,000.

This is lower than the two costs calculated in A above. Hence Merrimac should buy from the new supplier.

C.

(i) If demand = 2,000,

then cost of buying from old supplier = 2,000*50

                                                               = $100,000

Cost of making = 25,000+(2000*40)

                         =$105,000

Cost of buying from new supplier = 50*100+(2000-100)*45

                                                         = $90,500.

Hence the parts should be purchased from the new supplier.

(ii) demand = 5000 parts.

Cost of buying from old supplier = 5,000*50

                                                       =250,000

Cost of making = 25,000+(5000*40)

                         = 225,000

Cost of buying from new supplier = 50*100+(5000-100)*45

                                                        = 225,500

The cost of making is the least and hence the parts should be made by Merrimac.

D.

Comparing the cost of old supplier and new supplier:

Let the quantity be "x" where both costs are equal.

Thus 50x = 50*100+45*(x-100)

50 x = 5000+45x - 4500

5x = 500

x = 100.

Comparing new supplier vs to make:  

Let the demand quantity be "x" where both costs are equal.

Thus 50*100+45*(x-100) = 25,000+40x

5000+45x - 4500 = 25000+40x

5x = 24500

x = 4900

Thus if x (or demand)<=100 then the parts should be purchased from the old supplier.

if x>100 but <4900 then the parts should be purchased from the new supplier.

if x>=4900 then the parts should be made by Merrimac.